GrowGeneration: The 'Pick And Shovel' Of Pot
- GrowGeneration is a hydroponics retailer that offers broad exposure to the rapidly growing US cannabis industry.
- With triple digit growth and a runway for expansion, the company is still in early stages of growth.
- The stock was a massive winner in 2020, appreciating almost 20X from its 52 week lows. Despite this, patient investors can realize additional upside from current levels.
The cannabis sector is emerging in the United States, where states are steadily moving in the direction of legalization. But because cannabis is still illegal at the federal level and the market is so new, it's not clear from an investor's standpoint how to get effective exposure to the upside of cannabis.
One of my favorite ways to invest in a given industry, is to focus on the "pick and shovel" role players. These companies benefit by providing a critical product or service to consumers/producers. In the cannabis field, one of my favorite "pick and shovel" companies is GrowGeneration Corp. (NASDAQ:GRWG). The company is a cannabis focused owner/operator of hydroponic and organic gardening retail stores. While the stock has a massively wide 52 week range, I see remaining upside for long term investors to take advantage of.
About GrowGeneration Corp.
GrowGeneration operates a chain of retail locations across 12 states, and did $193 million in sales for fiscal year 2020. GrowGeneration sells to cultivators and growers including commercial businesses, as well as home growers.
The types of products sold fall into two primary categories, consumables and non-consumables. Consumables would be supplies that are continuously used such as nutrients/additives, containers, soils, and more. Non-consumables would include lighting equipment, irrigation systems, and more. The above graphic gives a nice breakdown of sales.
Consumable products drive recurring revenues, especially from commercial customers that use high volumes of product. There is also project business that drives large, one-time expenditures as production facilities are built out.
The company's footprint in the US follows the lines state legalization. The current store count includes stores in:
- California (18 stores)
- Colorado (8 stores)
- Michigan (6 stores)
- Maine (5 stores)
- Oklahoma (5 stores)
- Washington (2 stores)
- Oregon (2 stores)
- Nevada (2 stores)
- Arizona (1 store)
- Rhode Island (1 store)
- Florida (1 store)
The company has long term goals of owning locations in all 50 major US states. In addition to this footprint, GrowGeneration operates an e-commerce site using the name GrowGen.Pro.
The company has kept a clean balance sheet, funding expansion by issuing shares.
Expanding As Legalization Spreads
GrowGeneration is steadily expanding its footprint, and I think that the slow and steady nature in which cannabis is being legalized state by state actually helps GrowGeneration. If it were to be legalized across the country all at once, there would undoubtedly be a flood of competition.
We can see below that while medical use and decriminalization has largely taken place across the country, there are still many states that have not yet legalized cannabis for recreational use.
Source: DISA Global Solutions
As more states loosen up restrictions on cannabis, GrowGeneration is steadily entering these markets. Just recently, a major domino fell when the state of New York gave the green light for recreational cannabis.
GrowGeneration is guiding to continued footprint expansion. The company is targeting to have 60 garden centers in 15 states this year, and to hit 100 garden centers by 2023.
This gives GrowGeneration multiple growth levers to drive rapid revenue growth. The rapid growth of the cannabis industry sparked 63% growth of same-store sales in 2020. But with added revenues from new garden centers and acquired assets, revenue growth in 2020 was a whopping 143% YoY increase.
This momentum will sustain itself because the tailwinds (cannabis growth and additional stores/markets) will continue for the foreseeable future. For 2021, management is guiding sales of $415M - $430M. This would be a YoY increase of 122%. In a growing TAM, GrowGeneration is poised for many years of double digit revenue growth.
Should Investors Be Concerned About Competition?
The main argument against GrowGeneration that I have seen is that being a retailer, it lacks a "moat" and that competition can easily take market share. There is some degree of truth to this, but I think this argument fails to give GrowGeneration enough credit.
GrowGeneration is what I refer to as a "niche" retailer. The company adds value by being focused and specialized in the cannabis industry. This means a greater depth of products available, and knowledgeable staff that can assist customers. This creates an overall experience that you see in other niche areas of retail such as a hardware store would, or an automotive parts store might.
Major players such as Amazon (AMZN) and Home Depot (HD) can (and have) entered the space by making product available, they won't provide the same depth and quality of consumer experience. I also suspect that as GrowGeneration grows and its reputation spreads, it will continue to win commercial business over more generic competitors.
Ultimately, the cannabis market will have multiple players that GrowGeneration will compete with. But given the market size (projected to grow to as large as $25B by 2025), there is room for multiple winners. Nonetheless, I expect GrowGeneration to be a leader in the space, and I just don't buy the argument that a larger, more generic competitor will put excessive pressure on them. We will see over time.
Looking At Valuation
The stock itself has been on a wild ride over the past year. So much so, that investors shouldn't be blamed for hesitating. The stock carries a 52 week range of $3.22 - $67.75, and currently trades at $50.64 per share. It is not often that you see a stock go almost 20X in just 12 months.
The stock must be overvalued after such a run, right? Ultimately, valuation is somewhat in the "eye of the beholder" so here is where I stand on GrowGeneration.
While GrowGeneration is a much younger (and riskier) company than its primary (publicly traded) competitors, the company is also growing much faster. For example, let's compare GrowGeneration to Home Depot:
Home Depot had a nice year posting double digit revenue growth, but is a mature business growing revenues at a high single digit pace over the past decade. GrowGeneration is growing at triple digits both in revenue, and in EBITDA. Home Depot has a market cap of $331 billion, versus just $3 billion for GrowGeneration.
I'm not saying that GrowGeneration will grow up to be anywhere near as large as Home Depot, but it's fairly obvious to me that GrowGeneration has much more room to grow than Home Depot. Despite this, valuations are within ear shot of each other. Growing at triple digits, it will take but a couple of years for GrowGeneration to become less expensive that Home Depot on a valuation basis. Multiples change quickly when you grow that fast.
With this growth rate and the long runway ahead for GrowGeneration, I don't think the current valuation is unreasonable if you are willing to hold the stock for a few years.
The cannabis industry is only getting bigger, and there are a lot of ways to invest in that upside. GrowGeneration offers exposure to the underlying infrastructure that will drive the industry, and the company happens to have strong fundamentals to boot. While the stock may seem expensive after a wild run this year, long term investors can still enjoy sizable upside over the years to come.
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